Let’s say you’ve listened to your local personal finance reporter, and you’ve committed to saving more money. Good for you!
Unfortunately, right now, Americans who want to save for the future get dunked in a big bowl of alphabet soup: 401(k)s, IRAs, 529s, HSAs. If you want to save that dollar in a tax-advantaged way, where to put it?
* A 401(k), traditional IRA, or Roth IRA, for retirement savings? Many people are eligible for all three of these, and you can spend hours or days weighing your options.
* A 529 plan, for college savings? It works like a Roth IRA (money is taxed before it goes in, taxed free when it comes out), but can only be used for qualified education expenses.
* A health savings account (HSA) or flexible spending account (FSA), or both, for medical expenses?
Now, be careful. In most cases, you can’t transfer money between these accounts, so you’d better know ahead of time how much you’re going to spend on medical care, retirement, and college. You have a crystal ball, right?
What’s that? You want to save for retirement, college, and medical expenses? And for a down payment on a new house or car? Where’s the ibuprofen?
It would all be so much easier if you lived in Canada.
Introducing the Tax-Free Savings Account
Since January 2009, Canadian residents have been eligible to open Tax-Free Savings Accounts (TFSAs). They work almost exactly like Roth IRAs: you contribute after-tax dollars, and all withdrawals are tax-free. All Canadians 18 and older can contribute up to $5,000 (Canadian) a year to a TFSA, and you can stuff it with a variety of investments: regular savings accounts, CDs (called GICs in Canada), and mutual funds.
Unlike Roth IRAs, however, you can use a TFSA to save for absolutely anything. You don’t have to submit receipts. You can use the savings for college, medicine, retirement, or a pony. Furthermore, if you don’t contribute your full $5,000 this year, the leftover amount rolls over. I could, if I were Canadian, put $5 in my TFSA this year and $9,995 next year. (You can actually put in even more than this, in a way too complicated to explain but easy to do in practice.)
“They’re astounding,” said Chris Edwards of the Cato Institute, a libertarian think tank. “It’s a profound reform. It essentially eliminates taxation on savings for the entire middle class.”
Five grand a year is a significant amount of savings for most families–but not for the rich.
Edwards, who is originally from Canada, sounds a little homesick. As well he should. In 2002, he co-wrote a paper arguing that Roth IRAs should be converted into what he called Universal Savings Accounts (USAs, get it?). It describes a proposed reform nearly identical to the Canadian TFSA.
President George W. Bush’s administration had a similar idea dubbed Lifetime Savings Accounts; it went into several budgets he submitted to Congress in the mid-2000s. Each time, Congress stripped it out.
I spoke to a source at the House Ways and Means Committee, which would have to sign off on tax-free savings accounts in the US. They said nothing of the kind is currently in discussion.
I want my TFSA
Are Canadians actually using these new accounts? After all, they already had access to tax-advantaged retirement and education savings accounts, just like Americans.
Oh, TFSAs are a hit. According to Canada Revenue (the Canadian IRS), 4.6 million Canadians (about 15% of those eligible) have opened the accounts as of December 2009 and stashed $17.9 billion (CAD) in them.
“A TFSA is completely flexible,” said David Birkbeck, an executive at Royal Bank of Canada. “Those withdrawals can be used for anything. I’m sure it would take off in the US just as it has in Canada.”
The most popular use for TFSAs in Canada is emergency savings, according to a survey taken by RBC. But RBC promotes them for any number of purposes, including supplemental retirement savings.
I don’t want to leave you with the idea that the only people talking about TFSAs for America are on the political right. Elizabeth Warren, the Harvard law professor who advocates for (and might serve as chair of) a new consumer financial protection agency, promotes the idea in her book The Two-Income Trap:
[I]nstead of asking each family to carve its nest egg into separate little tax-advantaged slices, middle-class families could be rewarded for all savings. All savings–not just savings specifically designated for retirement or education–should be exempt from taxes.
Cato’s Edwards told me almost the same thing. “Any economist will tell you, all savings is good,” he said. “Whether it’s savings for 30 years until you retire or whether it’s savings for three or four years before you buy a car or whatever, it’s all good.”
This is not a partisan issue. Regardless of whether you’re a fan or foe of former President Bush, the Cato Institute, or Prof. Warren, tax-free savings account are a good idea. They appeal to conservatives because they promote individual choice about savings instead of a set of complicated, government-approved boxes, and because they provide tax relief to middle class families. They appeal to liberals because they would help ordinary Americans save more money, and because the effect on the federal government’s tax revenue would be small. (Canada hasn’t collapsed yet, after all.)
Unlike Edwards, I’m not persuaded that we should do away with the Roth IRA, but I think we should send a special team up north to appropriate Canadian tax-free savings accounts and bring them back to the US.
I’d open one today. Wouldn’t you?